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The anatomy of standard DSGE models with financial frictions

We compare two standard extensions to the New Keynesian framework that feature financial frictions. The first model, originating from Kiyotaki and Moore (1997), is based on collateral constraints. The second, developed by Carlstrom and Fuerst (1997) and Bernanke et al. (1999), accentuates the role of external finance premia. We tweak the models and calibrate them in a way that allows for both qualitative and quantitative comparisons. Next, we thoroughly analyze the two variants using moment matching, impulse response analysis and business cycle accounting. Overall, we find that the business cycle properties of the external finance premium framework are more in line with empirical evidence. In particular, the collateral constraint model fails to produce hump-shaped impulse responses and generates volatilities of the price of capital and rate of return on capital that are inconsistent with the data by a large margin.